February 2016

The Monthly


With this commentary, we plan to communicate with you every month about our thoughts on the markets, some snap-shots of metrics, a section on behavioural investing and finally an update on some of the people at MacNicol & Associates Asset Management (MAAM). I hope you enjoy this information, and it allows you to better understand what we see going on in the market place.

“Give me six hours to chop down a tree, and I will spend the first four sharpening my axe.” – Abraham Lincoln



The Numbers:




Market Commentary: A Bird in the Hand


“A bird in the hand is worth two in the bush”, an axiom which dates back to the seventeenth century, is oft-quoted and applied to various arenas; however, we believe that it can aptly be applied to the current situation that we are observing in the capital markets. The statement, of course, refers to valuing reality over possibilities, and can be easily used to explain the current correction occurring to what are typically considered high growth or momentum stocks.


High growth stocks or momentum stocks are those which are the fastest growing companies in the world; the most famous of these types of stocks are referred to as the ‘FANGs’, which stands for Facebook, Amazon, Netflix, and Google (now known as Alphabet). These companies are known by all and rank amongst the most valuable companies in the world – and for good reason. Apple, for example, has grown its sales from $24 Billion in 2007, to over $233 Billion in the company’s fiscal 2015, which is an average annual revenue growth rate of 28.73%. See Chart 1 below, courtesy of Forbes, to see a visual illustration of the revenue growth.

Chart 1:



Amazon, Netflix and Google have experienced similar annualized revenue growth rates over the past 5 years of 16%, 16.2%, and 14.65%, respectively. This sort of top line growth is exemplary for companies of their size, and the valuations of the so-called FANG stocks benefit from it; however, they also come to depend upon it. Once a company has been experiencing such rapid growth over a sustained period of time, their stock becomes a valuable commodity, and begins to trade at higher valuations. That is, put simply, the demand for their shares increases faster than the growth of their underlying business. The net effect of such a situation is similar to that of leverage on traditional investments; when the company meets or exceeds earnings, it out-performs the market, but when it misses or lowers estimates, the stock is crushed.  A prime example of this sort of behaviour can be illustrated through the recent price activity of LinkedIn’s stock price, which was one of the top performing stocks of the second half of 2015, rising ~50%. Tides have turned in 2016, as the company’s stock is down 55% year-to-date, following a quarterly earnings report where they actually beat earnings. The issue was that future estimates were brought down drastically; the curtain had been lifted, in a sense, and instead of trading of off idealist future estimates, LinkedIn investors and covering analysts were forced to readjust their expectations. A similar – while slightly less drastic – story can be seen with Apple’s stock price, following earnings guidance which predicted Q1 2016 to bring the first year-over-year revenue decline in 13 years. As you can imagine, such a statement is likely to encourage the thought that Apple’s 28.73% annualized revenue growth rate will be hard to maintain. The stock is down 11% year-to-date.


The point of this overview is meant to establish and reiterate our policy of attempting to build portfolios which can grow in a stable manner, annually, while avoiding massive swings in value. Part of the pillars of this strategy is to avoid high momentum names such as the ‘FANG’ stocks, which are wont to swing either direction violently if data that is announced does not fit the exact (optimistic) future growth scenario that is implied by their valuations. Especially in a precarious market such as we are currently in, we prefer to focus our investing on names which exhibit strong value under more reasonable or conservative economic scenarios.


Another aspect of this strategy is one that we have discussed in prior commentaries: precious metals as portfolio insurance. We have been in favour as using precious metal stocks as insurance for surprisingly negative market scenarios for a long time, and believe that the current environment is a perfect example of their usefulness. As can be seen on Page 1, year-to-date, the TSX is down 5.6%, the S&P 500 is down 9.3%, the Dow Jones is down 8%, and the technology and momentum-heavy Nasdaq is down 14.5%; meanwhile, the Gold and Silver sector Index has risen 25.3%. The reasons for this can mostly be attributed to a shift in investor sentiment, rather than a shift in the underlying macro-economic situation. Global growth is slow, Chinese growth is slowing, Brazil, Venezuela, Taiwan, South Korea and Japan are all in recession, and the only area of optimism seems to be the US consumer data; this data is not pleasant, but at the same time, the developments are not nascent and, on top of that, are mostly internationally focused. It can be easily seen how international issues can affect an economy of a commodity-driven country such as Canada, but the effect on the U.S., who generates 70% of its GDP from internal consumption, should be contained. This last point basically summarises the prevailing sentiment of the last half of 2015: growth is slow, but steady, and the US consumer has a lot of tailwinds that should be to their benefit; stocks may be sideways, but there shouldn’t be a huge leg down or recession. The shift in sentiment occurred once China’s slowing growth began taking over the news again and the ISM Non-Manufacturing data, a key proxy for the US consumer economy, disappointed estimates. This data also came at a time when economists were mulling over retail sales data from the back-to-school and Holiday seasons, which had also disappointed. These weak data points invoked uncertainty in regard to the Fed’s interest rate schedule, as well as the underlying health of the American economy. There was now an emerging belief that they would be unable to raise rates as quickly as they stated, with an outside chance of actually needing to re-institute some form of Quantitative easing. This sentiment, combined with fear of further correction and the lack of fear for higher near-term interest rates, drove investors into the two primary ‘safe haven’ assets, and out of more risky asset classes such as traditional equities. Chart 2 below visually shows how both US long bonds (represented by the iShares Barclays 20+ year ETF, TLT) and precious metal stocks (represented by the GDX Gold Miners ETF) were significantly able to out-perform the S&P 500 (INX) year-to-date. We continue to believe that holding an allocation to safe haven assets serves as insurance against periods of harsh volatility, uncertainty and sharp changes in investor sentiment, and we believe that the current scenario provides great evidence of times when this strategy is useful.

Chart 2:



Behavioural Investing: Pessimistic views on Optimism


One of the primary things that we wished to emphasize in the last portion of the commentary, was the importance of sentiment. The general capital markets are a collaboration of the sentiment of all market participants, and as such, the prevailing ‘animal spirit’ or sentiment of the group is vitally integral to understand. However, the difficulty inherent in this fact is that one isolated person cannot hope to understand the likely movements of the markets without actively seeking both congruent and adverse opinions. At Macnicol, we strongly value seeking out all opinions, whether they agree with our thesis or not, in order to properly understand the current market, as well as to avoid the next behavioural investment topic that we’d like to discuss – Optimism Bias.


Optimism Bias stems from the idea that we often have much higher conviction that our own opinions or competencies are better than those of others. More often than not, this is not true. For example:


  • A Yale study found that humans are only correct 80% of the time when the say that they are 99% certain.
  • A study by McCormick, Walkley and Green found that 80% of drivers believe that their driving skills are above average.
  • SEED Magazine found that 70% of High School students thought that their leadership skills were above average, while only 2% believed theirs were below average.
  • A similar study found that 85-90% of people thought that the future would be brighter than their present situation.


To sum things up, we are, by nature, optimists. This phenomenon is generally good for social issues, but it is also a large reason why that we believe collaboration and deliberation is vitally important to establishing an investment thesis. In order to create both our macro thesis and any individual thesis on an individual investment, we attempt to consider all viable and relevant viewpoints; more often than not, we have found that most people have grains of truth to their own opinions and have reasons to have high conviction. Therefore, we have found that the strongest way to avoid Optimism Bias is to collaborate with a team, consider alternate ideas, and to always keep an open mind.











David A. MacNicol, B.Eng.Sci., CIM, FCSI


Portfolio Manager

MacNicol & Associates Asset Management Inc.

December 2015